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Loan Level Price Adjustments for a Mortgage
What is a Loan Level Price Adjustment?
Loan level price adjustments (LLPAs) are additional fees assessed to conventional mortgages based on certain borrower and loan risk characteristics.
How Do Loan Level Price Adjustments Work?
Loan level price adjustments are assessed by Fannie Mae and Freddie Mac, which are the two largest government sponsored enterprises (GSEs) that buy mortgages from lenders. Fannie Mae and Freddie Mac buy mortgages from lenders which in turn enables lenders to offer more mortgages to borrowers and generate more revenue. Lenders receive fees when they sell loans to Fannie Mae and Freddie Mac. Loan level price adjustments reduce the amount of fees lenders receive when they sell loans to Fannie Mae or Freddie Mac. Lenders usually adjust for loan level price adjustments by charging borrowers a higher interest rate. Charging a higher interest rate enables lenders to earn higher fees when the sell mortgages to Fannie Mae and Freddie Mac, which offsets the negative impact of the loan level price adjustments.
Loan level price adjustments were implemented by Fannie Mae and Freddie Mac to account for borrower and loan risk. In short, the idea behind loan level price adjustments is that mortgages for higher risk borrowers and loans should be more expensive so extra fees, or price adjustments, are added to the base price of a loan based on certain risk assessments. Risk assessment factors that determine loan level price adjustments for a mortgage include borrower credit score, loan-to-value (LTV) ratio, loan size, loan type, loan purpose (such as a cash-out refinance), property type and property occupancy.
Loan Level Price Adjustment Example
Loan level price adjustments are hard to explain so it is helpful to compare them to buying a car. A base car model has one price before you include any options such as power windows, cruise control or four wheel drive. If you add the cost of the options, the price of the car increases.
Loan level price adjustments operate in a similar way. A base mortgage charges a certain interest rate and costs. Additionally, lenders receive a certain fee when they sell the mortgage to Fannie Mae or Freddie Mac. Similar to car options, loan level price adjustments increase the cost of the mortgage and reduce the fee lenders receive when the sell the mortgage. With car options, the price of the car usually increases because you are paying for fancy upgrades. In some cases, however, as a negotiating tactic, the car dealer adds the options without raising the price of the car, which reduces their profit margin.
The same logic applies to mortgages. With loan level price adjustments, because of great borrower or loan risk, the lender usually increases the price of the mortgage by charging a higher mortgage rate or closing costs. In other cases, the lender does not pass on the increased cost to borrowers and instead keeps the loan terms the same and takes a smaller profit on the mortgage.
Loan Level Price Adjustment Factors
A mortgage is assessed loan level price adjustments based on a borrower’s credit score and loan-to-value ratio. Loans for borrowers with lower credit scores and higher loan-to-value (LTV) ratios are assessed higher loan level price adjustments. This explains why borrowers with low credit scores pay higher interest rates than borrowers with higher credit scores and why borrowers who make a down payment of at least 20% pay lower interest rates than borrowers who make smaller down payments.
Loan level price adjustments are also applied to non-owner occupied and multi-family properties as well as cash-out refinancings, smaller loan amounts (less than $250,000) and certain mortgage programs. All of these loan level price adjustments add up to price of the mortgage ultimately paid by the borrower. Loan level price adjustments are applied to almost all conventional mortgages unless you make a down payment of 40% or more. The greater the amount of loan level price adjustments the higher the interest rate.
How Loan Level Price Adjustments Impact Your Mortgage Rate
It is important to highlight that loan level price adjustments are not directly added to your mortgage rate or closing costs. Instead, they reduce the amount of compensation lenders receive when they sell conventional mortgages to Fannie Mae or Freddie Mac, and instead of making less money on a loan, lenders usually pass along the cost to borrowers. Borrowers should think of loan level price adjustments as a deduction to the fees lenders receive that borrowers pay for by paying a higher mortgage rate.
For example, based on standard loan pricing a lender may receive a 1% fee, or $1,000, when they sell a $100,000 mortgage to Fannie Mae or Freddie Mac. If a .250 loan level price adjustment is applied to the loan, that .250 is subtracted from the lender’s 1% fee which means the lender receives a .750% fee, or $750. In most cases, lenders increase the interest rate charged to borrowers to account for the loan level price adjustment so that they can earn a similar fee on the mortgage. The higher the interest rate, the higher the fee lender receives when they sell the mortgage. So lenders usually makes out fine when loan level price adjustments are applied because the fees are passed on to borrowers in the form of higher interest rates.
Loan Level Price Adjustment Table
The table below outlines loan level price adjustments based on credit score and loan-to-value ratio. The figures in the table represent deductions to the fees that lenders receive from Fannie Mae or Freddie Mac. For example, for a borrower with a 680 credit score and 85% loan-to-value (LTV) ratio, the loan level price adjustment, or deduction to lender fees, is 1.5% of the mortgage amount. Please note that additional loan level price adjustments are applied for other borrower or loan risk factors such as loan size, loan purpose, loan type, property type and property occupancy.
Source: Fannie Mae
What Borrowers Need to Know About Loan Level Price Adjustments
Although loan level price adjustments have a significant impact on mortgage pricing borrowers are usually unaware of how they are applied and in practice it really does not matter. Lenders are not required to disclose loan level price adjustments and borrowers should focus on mortgage rate and closing costs when shopping for a mortgage. The mortgage rate and closing costs quoted by a lender already reflect the impact of loan level price adjustments. Although loan level price adjustments are standard across all lenders, interest rates and closing costs vary because lenders have discretion in setting mortgage pricing. Knowing how loan level price adjustments work, borrowers should compare interest rates and costs from at least four lenders to find the mortgage with the best terms.
Loan Level Price Adjustments Do Not Apply to Government-Backed Mortgages
Loan level price adjustments only apply to conventional mortgages and not government-backed mortgages such as FHA, VA and USDA home loans. This is one of several reasons why the interest rate for FHA, VA and USDA mortgages is lower than the interest rate for conventional mortgages. The VA home loan program charges borrowers an additional upfront funding fee while the FHA and USDA programs charge borrowers additional upfront and ongoing mortgage insurance fees. Borrowers should compare the interest rate, closing costs and extra fees for government-backed mortgages with conventional loans to determine the financing option that is right for them.
Sources
"Loan-Level Price Adjustment (LLPA) Matrix." Fannie Mae Single Family. Fannie Mae, October 2 2019. Web.
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